Opinion: It’ll take more than ‘whatever it takes’ to fix the eurozone

3 years after Draghi’s speech, the economic and political crises are still building

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Mario Draghi prevented a financial meltdown with three little words, but it wasn’t enough to halt the economic and political crisis that is building in the eurozone.

By

MatthewLynn

They were arguably the three most successful words in central banking history.

Three years ago this weekend the president of the European Central Bank, Mario Draghi, pledged that he would do “whatever it takes” to save the euro
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. It may have seemed an obvious enough promise to make at the time, and it was greeted with a certain amount of cynicism. And yet it did the trick.

Since then, despite the battering it has received in Greece, and the rise of populist anti-euro parties elsewhere in Europe, the euro crisis has been contained.

The soaring bond yields that once threatened to bankrupt Italy and Spain have fallen steadily. Extraordinarily, both countries can now borrow money significantly more cheaply than the mighty United States. Fears that the single currency might be pulled apart overnight by ructions in the financial markets have been safely put to rest.

The trouble is, three years down the line “whatever it takes” is no longer enough.

In fact, a financial crisis has been turned gradually into an economic crisis — and that is turning into a political crisis. At the same time a liquidity crisis has been turned into a solvency crisis. There is no evidence that Draghi will be able to find answers to those issues — and they certainly won’t be fixed with a single speech.

It is easy to forget just how dire the situation across Europe was when Draghi took charge.

As he took the stage at investment conference in London on July 26, 2012, the eurozone had been battered by the financial markets. Greece had gone bust and had to be bailed out by its neighbors. It was swiftly followed by Portugal and Ireland. Bond yields were rising alarmingly in Italy and Spain, at several points breaching the 6% level at which their debts would become unsustainable.

European leaders were convening at crisis summits on an almost weekly basis, coming up with fresh plans to save the currency, few of which survived the next morning. It was chaos, and to many it looked as if the euro might not survive the year.

So far, he has turned out to be right. Back then, the nub of the problem was that the markets did not believe the ECB was a real central bank — that is, one that in the last resort would always print enough money to prevent a government going bust, at least so long as it agreed to whatever bailout terms were imposed by its partners.

What Draghi was making clear was that on his watch it would be. Any hedge fund shorting Italian or Spanish bonds would know that it would be facing the firepower of the central bank of what remains the largest economic bloc in the world. Not surprisingly they backed off. The trade was suddenly too dangerous.

The impact has been dramatic. At the peak of the crisis, Spanish 10-year bond yields
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hit 7.5% . Now they are 1.92%. Italian bonds
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hit a peak of more than 7%, but now they are less than 2%.

In two of the bankrupt nations, the falls have been even more extreme. Portugal and Ireland are back on the road to recovery. The days when every government bond auction was a nail-biting event have been safely consigned to the past. On that measure, Draghi’s intervention speech was a stunning success, and he deserves credit for it. Whether he would ever have been able to make good on the pledge, probably no one will ever know. He never needed to. The threat alone was enough to bring the capital markets to heel.

The trouble is, it did not fix any of the underlying issues. What two years ago was essentially a financial crisis has now turned into an economic one.

A quick look at the numbers is a stark reminder of just how much trouble the continent is still in. Forget about Greece — it has descended to its own deep level of economic hell. Finland, a prosperous North European country, which stuck to all the rules, is now deep in recession, with another 0.5% contraction in gross domestic product forecast for this year. Its economy is now 5% smaller than it was in 2008.

Portugal is running up unsustainable debts, with a debt-to-GDP ratio of 130%, the bulk of it owed to foreigners — a situation that is about as stable as a toddler riding a bicycle. Italy remains the country that growth forgot, with its GDP still stuck below the level it was when it joined the single currency all the way back in the 1999, while unemployment climbs relentlessly, and the exodus of smart young Italians to countries where they actually have a chance of getting a job gathers pace.

Spain is held up as the one example of a country reforming its way back to competitiveness, and has put on a growth spurt. But unemployment remains crushing, at more than 23% of the workforce, while the jobless rate for young people is more than 50%. None of that can be described as a success.

That is surely unsustainable. In Greece, the electorate is already in rebellion against grinding austerity, even if for now they appear to have knuckled down to yet another deep recession. Spain faces volatile elections next year with the Podemos party expected to make big gains; in France the explicitly anti-euro National Front is gaining in the polls; in Italy, the Five-Star Movement is a big force. Sooner or later, a party committed to leaving the euro is going to win power.

True, three years on from that speech, it is clear that the financial markets are not going to break the single currency. The essential firewall has been put in place to prevent that. But the economic crisis is getting worse. Draghi is a smart and successful central banker. The eurozone is lucky to have him.

Even so, he is not going to be able to save the eurozone single-handedly, no matter how hard he tries.

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